BUS 320 Desai Ch3

You are the manager of a hedge fund and believe that General Motors (GM) is going to do really well next year. Specifically, you are certain that GM is going to outperform Ford Motor Company, a rival car company, and you wish to set up a trade. Which of the following is an investment strategy that will make money if you are right?

• Long GM, long Ford

• Long GM, short Ford

• Short GM, long Ford

• Short GM, short Ford

What is the main benefit of diversification?

• It increases the amount of risk in your portfolio, relative to the amount of return.

• It decreases the amount of risk in your portfolio, relative to the amount of return.

• It increases the amount of risk and return for your portfolio.

• It decreases the number of stocks in your portfolio.

When companies report earnings that are only a few cents below their previous estimates, why do their stock prices go down by so much?

• Even a few pennies can make a huge difference when multiplied over millions of shares.

• Accounting earnings are inaccurate.

• Such an earnings miss indicates the possibility of a future dilution.

• Investors can’t be certain if the company failed to meet its estimates because of coincidence or bad luck, or if the missed estimate is a signal that management is obscuring deeper problems.

You are excited about an investment opportunity in Dow Chemical, a multinational chemical corporation, because it is undervalued relative to peers. Which of the following companies should you short to better capture the potential outperformance of Dow?

• Bayer, a multinational chemical and pharmaceutical company

• British Airways, an airline

• Consolidated Edison, a power company supplying electricity to the New York City region

• Not any one particular company; you would want to diversify to gain an advantage

Which of the following is an example of a bad incentive?

• Investors want to make money so they invest in companies that are doing well.

• Analysts are afraid to recommend “sell” for a company’s stock because that company may not do business with their employer in the future.

• CEOs take large risks with their companies, because a great deal of their personal wealth is tied up in stock options.

• Pension funds invest in high-quality companies because they want to take care of their retirees.

Most equity research analysts are employed by (and receive their paychecks from):

• Individual households

• Industrial companies

• A sell-side firm

• The media

Which of the following are possible consequences of the usual compensation model and industrial structure for equity analysts? (Choose all that apply.)

• Analysts will work hard to provide accurate valuations for companies.

• High-ranking analysts may “herd” by choosing valuations similar to other analysts to protect their position in the rankings.

• Analysts will always recommend “sell” in order to gain profits from selling short.

• Low-ranked analysts may make outlandish and contrary predictions, hoping that a lucky break will propel them to the top of the rankings.

In 2012, Facebook conducted its initial public offering and sold 421 million shares to the public for the first time. Which player in the capital markets helped it sell these shares?

• Analysts

• The buy side

• The sell side

• The media

In 1989, the private equity firm KKR was involved in a famous $31 billion deal with RJR Nabisco. What does private equity do?

• Invests in private pension funds on behalf of companies

• Buys companies, improves them, and then sells them to another private investor or the public markets

• Combines the private equity assets of thousands of investors and invests those assets in a broad portfolio of diversified assets

• Advises companies on private investors who may be interested in buying bonds from them

In Freakonomics, authors Steven Levitt and Stephen Dubner note that professional realtors sell their own homes for 10 percent higher prices, on average, than comparable homes they sell for others. Which problem of capital markets might this be a manifestation of?

• The buy side

• Board oversight

• Herding

• The principal-agent problem